Saturday, February 17, 2007

Zecco.com Update

I’ve got some good feed back on my review (Part 1, Part 2) of Zecco.com the online broker with free trades. I was pretty even handed: Zecco does offer free trades as promised and their order execution was reasonable; however, I experienced some problems with withholdings and wasn’t happy with the reporting. In the end, the withholding was recorded in the monthly statement and it was already forwarded to the IRS by Penson Financial (Zecco’s clearing firm) by the time I had all my paper works in. This is a big motivation for me to file my taxes as soon as possible this year. I haven’t made further trades with Zecco although the account is still open. I’ll re-evaluate the situation after I get my tax refund.

In the meantime, Zecco has been making improvements as described below. They cannot come at a better time as the competition for “zero commission” is heating up.

Zecco now offers IRAs
This is a new offering from Zecco. Roth IRA, traditional IRA and rollover IRAs are now available. The same free trading applies to IRA accounts as well. I’m still trying to get a clarification as to whether one can own a taxable account as well as an IRA account and get free trading in both. There was a rule that one cannot own more than one account (e.g. individual + corporate) and get free trading in both.

There is a serious drawback though, in that Zecco is charging an annual fee of $30 for IRAs. While it is not a deterrent for frequent-traders, it will be a big put-off for those who are price conscious and plan to adopt an ETF based index strategy, especially since there are so many other online brokers that offer no fee IRAs.

Virtual Trailing Stop Orders
A virtual trailing stop order (VTSO), is a stop order that adjusts as the price of a security moves. What you do is you enter a stop price is placed at a set distance above or below the market price, depending on whether it is on a long or short position. And, the stop price then adjusts upward as the stock appreciates, maintaining the set distance. The purpose of this order is to maintain a set level of potential loss at any point in time while allowing for continued appreciation as long as the price does not fall to the stop loss.

Say you’re long stock ABC which is currently trading at $100, you want to protect yourself from a decline in the stock price, i.e. either protect existing profit or limit potential loss. You could enter a stop order (A stop order is an order that becomes a market order once the stop price is reached. For long positions, it’s a sell order below the current price; for short positions, it’s a buy to cover order above the market.) at $95 which limits potential loss to $5 per share from current levels, any slippage notwithstanding. However, if ABC appreciates to $120 and you haven’t kept up with your stop, you’re now opening yourself to a potential $25 decline.

This is a concern for those who can’t monitor their stops constantly. Don’t worry, trailing stop orders come to the rescue. Zecco’s implementation is a fixed distance trailing stop. In the above example, you enter a VTSO at $5 (note, not $95! This was confusing giving their interface. See this tread at the Zecco forum). As the stock appreciates, the stop price is lifted, always at $5 below the high after the order was entered. In the above example, when the stock makes a new high at $120, the stop would be at $115. This way, you still benefit from appreciation in the stock, and your gains will never slip away more than the pre-determined amount.

Trailing stops are best after an extended move when you want to protect your profit. Using a tight stop during a period of consolidation may get you out of the stock prematurely only to see it taking off without you.

Some online brokerages such as TDAmeritrade implement trailing stops using a percentage off the high. There isn’t a big difference between the two. Granted more sophisticated implementations would also allow a limit order instead of a market order to be triggered, this is still a big improvement from Zecco and I applaud their effort.

The competition is heating up
As implied in the opening paragraph, even “zero commission” is not immune to competition. Previously, I have mentioned Bank of America which offers 30 free trades/month (vs. Zecco’s 40 free trades/month) in a dozen states around the country. One catch is that you have to have $25k in deposit accounts with them. The drawback is that BoA imposes a $50 semiannual “brokerage account maintenance fee” for accounts under $50k, so the deal is not attractive to investors with low account balances.

The latest contender is Wells Fargo which is offering 100 free trades/yr when the equity in the brokerage account meets a minimum of $25k. There are no minimum deposit account requirements. What sets it further apart is that many no-load mutual funds are also eligible for commission free trades. Trades beyond the first 100 cost $5.95 each which is also reasonable. With this offer, Wells Fargo has leapt to the front of the pack among ultra-low commission brokers in my opinion.

One of the main concerns with Zecco is how unproven it is. Even though the accounts are FDIC insured, no one knows how long it would take FDIC to respond if a catastrophic event does happen. On the other hand, both Wells Fargo and BoA are 1st class institutions. I hope Zecco can respond to this challenge. Competition can only be good for us individual investors.

Now for some idle speculation completely unrelated to online brokerage comparisons. If you’re wondering why Wells Fargo suddenly became so generous, or whether HSBC can make any money by offering a 6% interest rate on their savings account, my over-active mind has a theory. It is well known that consumer deposits are among the cheapest financing channels for banks. Is it purely coincidence then, that Wells Fargo and HSBC Household Finance top the list of subprime lenders according to this website? While I’m not suggesting either is going out of business, or their account holders are in any danger (HSBC is something like the #3 bank in the world and Wells Fargo is the highest rated bank in the US), the timing does strike me as a little too coincidental. It is entirely possible that their subprime lending divisions are under pressure and they want some extra liquidity to ensure that nothing “unexpected” happens. Just food for thought.